The high cost of NATO’s dwindling peace dividend

Paratroopers of NATO armies take part in "Swift Response 2017" military drill, a part of "Saber Guardian 2017" exercise, at Bezmer airfield, Bulgaria, July 18, 2017.

Stoyan Nenov/Reuters

Picking through the avalanche of criticism set off by U.S. President Donald Trump’s diplomatic misadventure through Europe this month, one commentary stands out.

John Kerry – former U.S. secretary of state in the Obama administration – launched a 400-word firebomb on Twitter after Mr. Trump’s inflammatory meetings with North Atlantic Treaty Organization leaders, in which the President demanded immediate increases in military spending and threatened to pull the United States out of the mutual-defence partnership. Mr. Kerry’s summary of what the President is putting at risk hit the nail on its poignant head.

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“He diminishes alliances we built to safeguard an economic and strategic force that has allowed millions of people to live in freedom,” he said in a letter posted to Twitter.

It’s no accident that Mr. Kerry included the word “economic” in describing NATO’s importance. The President’s antipathy toward his NATO allies – his instincts to shift the United States to a more inward-looking, self-interested and increasingly isolated superpower, while openly courting a powerful traditional foe in Russia – has deep economic implications, in addition to the military and political ones.

The world order that emerged from the solidarity of NATO’s collection of Western industrial powers, coupled with the collapse of Eastern European communism and the end of the Cold War, fostered a rare global stability that allowed an increasingly internationalized economy to flourish, while reducing the financial burden of increasing militarization. It’s what economists and political leaders referred to hopefully as the “peace dividend” in the early post-Cold War days of the 1990s. It has become so ingrained in the global economy as to be largely taken for granted.

But now, for the first time in a generation, it has been thrown into doubt. And while it’s debatable whether the peace dividend generated the kinds of economic benefits that our leaders of a generation ago envisioned, there’s little doubt that a breakdown of the NATO-led world order would bring with it economic costs.

“The benefits of the core logic of NATO are enormous,” says Michael O’Hanlon, senior fellow in foreign policy at the Brookings Institution, a Washington-based think tank. “A world order where two-thirds of world GDP is at least loosely organized in what you might call a Western coalition – this is very stabilizing and very good for economic growth and for international stability writ large, compared with any other model we’ve seen in history. That really is the point on which we should always begin these discussions.

“In that sense, NATO is a fantastic bargain,” he says.

And it has become an even better bargain in the years since NATO’s de facto victory in the Cold War against the Warsaw Pact countries of Eastern Europe, as the communist regimes of those countries collapsed in the late 1980s and early 90s. Global defence spending, as a share of GDP, has declined from 4 per cent in 1985 to a bit more than 2 per cent today, according to data from the World Bank and the Stockholm International Peace Research Institute. European Union spending as a share of GDP is hovering near its lowest levels in 58 years of World Bank/SIPRI data.

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The United States, despite Mr. Trump’s complaints about its oversized share of NATO military spending, has similarly benefited. In the mid-1980s, U.S. defence spending ate up more than 6 per cent of its GDP. Today, it’s a little more than 3 per cent.

Some experts have argued that many NATO countries went too far with curtailing their military investments, leaving their forces underfunded and in serious need to replace and upgrade worn, outdated equipment. Nevertheless, the scaling back of defence spending has been a windfall for government budgets.

But the peace dividend goes further than just the savings to the fiscal bottom line. Many economists argue that defence is not a particularly productive use of money in an economy; reducing military spending allows more efficient allocation of those resources, finding its way into investment alternatives that can expand economic capacity and improve productivity.

Certainly, the slowdown in military spending after the Cold War coincided with the longest postwar economic expansion in history. While that was also a period of dramatic globalization and trade liberalization that contributed greatly to the expansion, one could argue that this global trade peace was a byproduct of the relative global military peace of the era.

In the 1980s, annual productivity growth (measured by output per hour worked) in the Group of Seven countries averaged 2.1 per cent. In the 1990s, the decade marking the end of the Cold War, G7 productivity growth averaged the exact same 2.1 per cent. In the pre-recession period from 2000 to 2007, average G7 productivity growth slipped to 1.4 per cent.

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It’s notable that despite the savings on defence budgets, the G7’s overall government spending as a percentage of GDP actually edged higher in the period between the end of the Cold War and the Great Recession. Some economists have argued that the peace-dividend productivity effect works best when the savings from defence spending are redeployed by the private sector, and doesn’t work well at all when governments simply find something else to spend the money on. (In a 2012 paper for U.S. think tank the Cato Institute entitled Economic Effects of Reductions in Defense Outlays, economist Benjamin Zycher noted that while there is a high correlation between private-sector investment and GDP growth in the United States, there is almost no correlation between government spending and GDP growth.)

Still, reductions in the defence component of budgets have certainly given governments more fiscal flexibility – something NATO countries stand to lose as they look to rebuild their military budgets. At the alliance’s 2014 Wales Summit, the membership pledged to increase spending, with a goal to reach 2 per cent of GDP within a decade. While many members, including Canada, look unlikely to reach that goal, the pledge nevertheless will put upward pressure on budgets throughout NATO – even as many governments are still digging their way out of the debt hole created during the Great Recession and the protracted recovery. Mr. Trump’s demands that the NATO allies increase their spending much faster than that could further turn up the heat.

Canada would need to essentially double its current $20.4-billion defence budget if it were to reach NATO’s 2-per-cent target overnight. The government announced a plan last year to increase its defence budget by 70 per cent over 10 years, which would add about $12-billion to its annual cost by 2026-27. And that would still only raise the spending-to-GDP ratio to about 1.4 per cent, taking into account forecast GDP growth.

“In general, increasing military spending rapidly would have adverse impacts,” says Appalachian State University professor Jari Eloranta, who specializes in the economic history of military spending.

He notes that with most NATO economies well into the expansion phase and experiencing strong growth, it’s entirely the wrong time for governments to be overstimulating the economy with large amounts of new spending. “It would be the wrong time of the business cycle,” he says.

What’s more, he says, history has shown that a rapid spending increase “creates a huge potential for waste,” as governments look to move money quickly without a coherent long-term plan, while military contractors jack up their prices in response to the surge in demand.

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He adds that for many European countries that have been battling hard since the recession to rein in their debts, a dramatic increase in military spending now would be untenable.

“I can’t find any good economic rationale for ratcheting it up,” he says.

But the alternative – if NATO partners don’t substantially increase their spending, and Mr. Trump follows through on his threats and pulls the United States out of NATO – would have much more dire economic consequences.

In that scenario, Mr. Eloranta predicts the collapse of NATO, forcing a costly and destabilizing rush among many countries, especially in Europe, to rapidly increase their defences in the absence of the NATO shield.

“It would lead to an arms race, there’s no doubt about it,” he says. “It could potentially lead to a global recession.”

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